Defeating Frankenstein’s monster: A tale of the financial industry’s fight against synthetic identity fraud

By Alex Tonello, Chief Revenue Officer, Trustfull

What do Mary Shelley and financial fraudsters have in common? They’ve both created fake characters that were made of component parts of other people. Or, to state its proper name in the case of fraudsters: synthetic identities.

This type of financial fraud is no work of fiction – unlike Mary Shelley’s Frankenstein novel. In 2022, 46% of organisations faced synthetic identity fraud and these schemes are expected to generate nearly $5 billion in financial losses by 2024 in the US alone. Fraudsters are pioneers and, like any other money-making industry, are utilising innovative technology such as artificial intelligence (AI).

It’s clear that the financial industry needs a mindset shift, especially as synthetic identity fraud is having a profound effect on the commercial ecosystem and regulatory scrutiny continues to be an industry hot topic. Fintechs and neobanks have struggled with the latter most recently, facing scrutiny over failures that allowed money to be released from flagged accounts, raising concerns about controls against financial crime, and even affecting banking licences from being issued.

This is why banks need to evolve beyond traditional verification methods, supporting the legacy systems with additional evaluation techniques and alternative data sources when opening accounts. The solution to the problem lies in fully understanding synthetic identity fraud and the risks it poses to banks.

The rising menace of synthetic identity fraud

Let’s be clear on the type of fraud we’re talking about. Synthetic identities are defined as the strategic amalgamation of genuine and false personal information, such as names, addresses, dates of birth, and other personal data to create new identities. This personal data is often selected because it has no associated credit history or the information was unlikely to be actively monitored — numbers for children, recent immigrants, elderly individuals, imprisoned people, and even the deceased.

This activity has evolved further as fraudsters now use stolen or synthetic identities to create shell companies to increase their legitimacy when setting up new business accounts, and borrowing money that will never be paid back.

It’s a sobering thought that authorities cannot be sure exactly how much is lost from synthetic identity fraud, by criminals that are seemingly invisible or hard to trace. Nethertheless, the UK government has issued advice on checking the identity of individuals and have released a new Economic Crime Plan, which highlights the urgent need to fight fraud.

By focusing on financial institutions, we learn that an estimated 95% of synthetic identities are not detected during the onboarding process. Some institutions are not always aware that they have been targeted by synthetic identity fraud — rather they incorrectly classify these accounts as a credit risk. In addition, fraudsters are capitalising on the inaction by companies hesitant to adopt effective software tools for detecting synthetic identities during account setup.

Enhancing Know Your Customer (KYC) with additional screening

Know Your Customer (KYC) checks are meant to establish and verify the identities of customers to assess the risk they present. Detecting fraudulent activity after an account is created can be challenging for any financial institution.

By conducting thorough KYC due diligence, banks are protecting their reputation and maintaining the trust of their customers and regulators. Failure to identify and prevent illicit activities can result in regulatory fines, legal action, and reputational damage.

Let’s not forget that fraudsters are always finding new ways to circumvent standard KYC procedures. So, enhancing these procedures with an additional layer of screening ensures that banks have accurate information about the background of their customers, detecting identity theft and synthetic accounts. Furthermore, it provides banks better information to make informed commercial decisions and helps safeguard banks and their customers from financial losses.

Therefore, a robust KYC screening process that is strengthened with additional checks using alternative data sources is essential for banks to meet their regulatory obligations, manage risks, prevent fraud, and maintain the trust of their customers and regulators. The extra layer of protection is a critical component of ensuring the integrity and security of the financial system.

Yet to be effective, these additional KYC checks must not introduce unnecessary friction to the onboarding process.

Silent checks and digital signals

Now is the time for all banks to explore digital signals as a powerful and predictive addition to the traditional methods of identifying fraud.

Tackling the issue at the source, at pre-screening and early on in the onboarding process, can be extremely effective in preventing synthetic accounts from being created in the first place. Silent checks on phone numbers, email addresses, IP addresses, devices and browsers are the first line of defence against financial crimes for banks and fintechs.

Banks should consider how they can gather new sources of digital signals and utilise machine learning to tackle this challenge head on. There is also an added benefit to implementing digital signal checks. It will not only prevent fraud but get the best consumers through faster.

The parallel between Mary Shelley’s creation of Frankenstein’s monster and the emergence of synthetic identities in the world of financial fraud is a thought-provoking analogy. Much like Doctor Frankenstein’s creation was a composite of disparate body parts, synthetic identities are composed of various components of real and fabricated personal information.

The stark reality is that synthetic identity fraud, unlike a work of fiction, is plaguing financial institutions with alarming statistics and substantial monetary losses, with expectations of further growth in the years to come.

In this ongoing fight against synthetic identity fraud, it is evident that the financial industry must embrace innovative solutions and a proactive mindset. The stakes are high, and the consequences of inaction are severe. By supplementing verification methods, investing in robust KYC screening, and leveraging digital signals, banks can fortify their defences and ensure the integrity and security of the financial system, ultimately safeguarding the trust and financial well-being of their customers and stakeholders.